Authors: Nabilah Binte Azhar & Keeven Cheong Aik Wei
Editor: Ho Chia Chun Daniel
About the Adoption
El Salvador’s leader, Bukele, has implemented the Bitcoin Law that passes with 74% of votes from the administration. Bitcoin is now recognised as a currency in El Salvador and businesses are required to accept either the US dollar or Bitcoin as a valid form of payment (BBC, 2021). Citizens have been incentivised to get on the Bitcoin wagon, with the government giving free Bitcoins and putting Bitcoin ATMs in place for easy cash-to-Bitcoin conversion (BBC, 2021).
However, Bukele’s decision to declare Bitcoin as an official currency of the state has boggled the heads of many, sparking disagreements nationwide and debates within the region on the feasibility of such a system. With so many uncertainties surrounding Bitcoin, can the ambitions behind declaring Bitcoin as a legal currency truly be met by El Salvador?
Reactions to the Adoption: Regional Ambitions and National Progress
Regional experts have reacted positively to the news, citing various reasons and opportunities that this can bring for the small country. Major stakeholders in Latin America have cited the progressiveness and potential of Bitcoin as a currency and transacting medium. Cryptocurrencies like Bitcoin allow anyone with a mobile phone to send or receive funds, regardless of location through a ‘wallet’. The ‘wallet’ is safeguarded on phones and protected by passwords or biometric mechanisms like fingerprints and manages the cryptocurrency which can then be exchanged for cash.
This allows holders of bitcoin to be able to enjoy the services of a bank without the need to open a bank account. 70% of El Salvador’s citizens do not own a bank account, which can discourage them from saving (Coker, 2021). However, with a Bitcoin wallet, savings are protected by a password or PIN, instilling confidence among citizens to have a regular saving of small amounts over time. Firms also allow bitcoin holders to receive interest similar to that of a bank.
Additionally, World Bank data also estimated that remittance to El Salvador, an integral portion of its GDP, makes up nearly 6 billion (Asamblea Legislativa, 2021). Looking at Figure 1 below, we can observe a general positive linear trend in the contribution of remittances to El Salvador’s GDP and can expect it to continue to increase in the future. However, much of it is lost to transactional costs. By adopting Bitcoin, it is believed that transaction costs, that would have otherwise been incurred through the typical remittance channels, would be significantly reduced by at least $400 million (Asamblea Legislativa, 2021). There will be a resultant boost in GDP that can be used as a means of greater funding and support for those in need in El Salvador.
Figure 1: Increasing Trend of Remittance Contribution to El Salvador’s GDP (World Bank, n.d.)
Why Bitcoin is unlikely to work in El Salvador
The price of Bitcoin essentially depends on the demand of the people since there is a limited supply of 21 million that can be mined. When demand for bitcoins increases, the price will increase and when demand falls, the price will fall. This means that sustaining the price of bitcoin and reducing volatility would require banks to take up more capital to hold bitcoin. There are thus 2 questions to address:
- Do Salvadorians have a strong demand for Bitcoin?
- Do the banks in El Salvador have enough capital to sustain Bitcoin?
It is unlikely that demand would be strong as Salvadorians, the target users of this implementation, have not been welcoming of the new Bitcoin law. A survey conducted by the Central American University also found that 70% of Salvadorians disagreed with the decision to adopt Bitcoin as legal tender (Hernandez, 2021). This is because many Salvadorans lack access to the Internet, smartphone, and technological education which can hinder the pick-up rate of Bitcoin. The very group that Bukele claims would be able to benefit the most may ironically not even be able to utilise the system.
Furthermore, protests broke out on the streets of El Salvador after the law had been announced, with many fearful about the huge risks of using Bitcoin. One risk of Bitcoin is its extreme volatility as its price has veered from lows of $21000 to highs of $46500 (Sparkes, 2021). Looking at Figure 2 below, we notice the erratic nature of Bitcoin’s volatility index, negating any patterns or seasonality. With major currencies having volatilities ranging from 0.5% to 1.0%, the current volatility rate of Bitcoin is 3.51%, with its recent peak last year at 10.58% (BuyBitCoinWorldWide.com, 2021). This brings about the risk of economic instability. Even though El Salvador has sought to address this by attempting to introduce a bitcoin-dollar exchange rate system, little has been said on how this would work in practice (Strohecker & Wilson, 2021). Such a system also appears to be overly complicated compared to using the USD instead.
Figure 2: Bitcoin’s Volatility Index against Price (BuyBitCoinWorldWide.com, 2021)
Another issue Salvadorians will face is the deflationary nature of bitcoin. For fiat currencies, the supply can be changed according to economic conditions to either stimulate or slow the economy. Comparatively, the supply of Bitcoin is limited at 21 million with only around 2.15 million to be mined (BuyBitCoinWorldWide.com, n.d.). While this means that prices, expressed in bitcoin, will fall over time, it is not a good thing. People will not be incentivised to spend and simply wait for prices to keep dropping, leading to a deflationary cycle where prices continue to fall, potentially leading to the collapse of the economy (Skalex, n.d.).
Additionally, protesters in El Salvador have already raised concerns that cryptocurrencies like Bitcoin can facilitate illegal transactions like money laundering. This is because transaction records are distributed across the internet beyond the reach of national jurisdictions, making crypto an ideal option for anyone trying to avoid stringent capital controls or evade financial sanctions (Brito, 2021).
All these factors point to weak demand for bitcoin.
Even though El Salvador had purchased 400 Bitcoin, equivalent to over $20 million, to hold its supply, it remains unclear if banks have sufficient capital to sustain Bitcoin in the event of a crash (Perez & Ostroff, 2021). Industry regulatory bodies such as the Basel Committee of Banking and Supervision have proposed that the amount capital banks should hold for crypto-assets should be on par with their exposure to cushion an absolute write-off, considering the high weighted risk of 1250% and 8% minimum capital required (The Straits Times, 2021). We can only look at the success of cryptocurrencies elsewhere in the world where these cryptocurrencies are backed by some of the largest banks in the world and some banks mitigate volatility risk by automatically converting bitcoin to various fiat currencies. However, in El Salvador, many banks lack the investment capacity and infrastructure to adopt adequate mitigation measures, making them unlikely to hold bitcoin (Fellba, 2021).
Our Recommendation: Adopting a CBDC system
El Salvador should also consider adopting a virtual currency tied to the central bank rather than a market-driven cryptocurrency, i.e. a central bank digital currency (CBDC). Currently, over 80 countries are working on developing their own digital currency, with a rising interest across the pandemic period (Business Insider, 2021). A positive case in the works is Nigeria’s e-naira which was recently launched this year. Similar to El Salvador, Nigeria reels in big contributions from its remittances, with it being the top recipient in Africa and valued at 17.2 billion (Smith, 2021). Aboyeji, the former CEO of Nigerian-based payments provider Flutterwave, has also shown optimism that e-naira can help serve the common purpose Bitcoin has, that is to provide easier access to foreign exchange, so long as the Central Bank of the nation pilots the system effectively (Smith, 2021).
Chivo, the Bitcoin wallet for Salvadorians, continues to be flawed while its identity verification system has been faulty, allowing hackers to access the accounts of users (Morris, 2021). Many businesses are also opting to be exempted from accepting Bitcoin for goods and services citing technological hindrances. With so many problems and resistance, the pick-up rate of Bitcoin is unlikely to increase in El Salvador and Bitcoin would struggle at least in the short term.
However, the supermajority Bukele's party possesses and the removal of a constitutional ban on consecutive presidential reelection means that Bukele is likely to continue his reign (Hernandez, 2021). Bitcoin will likely continue to be part of El Salvador’s future even if there is widespread opposition to it.
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